Tuesday, August 25, 2009

According to the Case Shiller index, which tracks home prices in 20 major metropolitan markets, home prices have fallen about 35% from their highs of three years ago in inflation-adjusted terms. Contrary to the widely-held view that the housing market is under tremendous downward price pressure due to a rising number of foreclosure sales, prices rose from March through June (though the lagging nature of this index means that home prices actually rose several months earlier). While rising foreclosures may depress prices in coming months, I'm very tempted to say that we have now seen the bottom in housing prices, at least as measured by this index. That would be very good news for home builders, banks, and all those who hold mortgage-backed securities, since it means that the number of homeowners who are "underwater" and facing foreclosure will soon be decreasing.

This surprisingly good news is fully consistent with the recovery we have seen in the market these past several months (i.e., the market has been figuring this out). Home builders' stocks have already risen over 130% from their recent lows, according to Bloomberg's index of leading home builders stocks, and bank stocks are up 150% from their lows.

As a side note, a very close acquaintance recently secured a $900,000, 30-year fixed rate mortgage with a rate of 5.375% for the purchase of a home in the Los Angeles area. I was amazed at how low the rate was (the nationwide average for jumbo loans is 6%), but he got it by putting up a 30% down payment and paying 1 point.

On the margin, this all adds up to some important green shoots in a sector of the economy that has suffered the most in recent years.

FHA is on its way to becoming another Freddie and Fannie disaster. The government keeps trying to "make sure" (to use Obama's favorite phrase) that as many people as possible can afford a home. Plus, the Fed is trying to make money as cheap as possible. These two government distortions could very likely lead to another housing bubble down the road. But it's not going to pop any time soon. It could take many years to pop. Meanwhile, this is a great time to take advantage of low prices and low interest rates. When the government creates an opportunity like this you are foolish not to take advantage of it.

The government is making lots of mistakes (again). This is why it makes sense to believe that the recovery is going to be sub-par, and unemployment will take a long time to come down.

Scott,I would add this is a great time to lock in, or fix low rates. That is about the only really good inflation hedge I know of for the average wage-earning, small saver in this country. Too many people "take advantage" of low rates by let them float on their biggest asset.

Dale, you are absolutely right. I've recommended before that people borrow at fixed rates, and I would reiterate that without hesitation. Short term rates are extremely low today but they won't stay this low for much longer.

Jay: Demographics are certainly a factor, but they don't change fast enough to make a difference over a period of one, two, or three years. The US population is ageing, but it will continue to grow for at least several decades. I don't see why this would change the way the economy responds to a given fiscal or monetary stimulus.

Paul: I suspect that the home buyer incentive could be a factor, but there are other things at work as well: lower interest rates and much, much lower prices. Housing is more affordable now than it has been for many years. That's a huge incentive, and the combination of all these things could easily explain a mild upturn in prices. I wouldn't read too much into the upturn, though. The important thing is that prices have probably stopped declining. That restores confidence in banks, and it encourages home buyers who have been on the sidelines. Demand for housing needs to grow to absorb all the foreclosures that are going to be hitting the market for the next 9-12 months. I'd be happy just to see prices stabilize over that period.